Mr. Colvin is Managing Partner and founder of Colvin & Co. LLP, an agriculture-focused investment manager. Mr. Colvin’s family has owned and operated farmland for over 120 years. Previously, he was an analyst at Credit Suisse in the Portfolio Management Group and at UBS Investment Research.... More

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The Environmental Protection Agency (EPA) is currently reviewing the proposal to approve the use of 15% ethanol blend gasoline from 10% to help achieve the Renewable Fuel Standards (RFS) goal for year 2022. Proponents of increasing the ethanol blend are concerned about the current constraints on the ethanol market are limiting future innovation and growth.

The increase to E15 will have substantial impact on the agriculture industry as the demand for grains used for ethanol production will increase for the higher ethanol production. However, implementation restrictions and regulations may limit the impact that an approval of E15 as the higher blend may be limited to vehicles 2007 or newer.

Renewable Fuel Standards

In 2007 the United States passed The Energy Independence and Security Act of 2007 (EISA), which will have far reaching impacts on the consumption of ethanol in the United States. The bill requires that the United States use 36 billion gallons of bio-fuels a year by 2022. To accomplish these goals, the EPA is required to set renewable fuel standards each November for the following year based on gasoline and diesel projections from the Energy Information Administration (NYSEMKT:EIA).

The EPA believes to accomplish this that the current ethanol blend in gasoline will need to be increased from 10% (E10). However, when and how this increase will occur is not set in stone. Currently the EPA is receiving pressure from producers and energy groups to deliver a decision as soon as possible. The motivation behind their urgency is the fear that the ethanol market will hit the blend wall, which is when the supply of ethanol meets the demand for ethanol. Ethanol consumption is currently being constrained by the cap of a 10% blend.

The concern of hitting the wall and continuing forward with ethanol production is that if the supply of ethanol is greater than demand, then margins and net income from ethanol will dwindle causing the growth and innovation within the industry to slow. This not only impacts the producers and blenders of ethanol, but also developments in vehicles and consumer expectations of the use of ethanol.

Impact on Agriculture

The increase from E10 to E15 will have a substantial impact on the demand for grains used in ethanol production, such as corn and soybeans, as more grain will be needed to produce the incremental ethanol. The increase will provide long-term support for grain prices and has the agriculture industry very excited as it will encourage current farmers to produce more grains and for new farmers to begin growing corn and soybeans. The EPA expects the total impact from the increased use of ethanol to increase net farm income by $13 billion in 2022.

EPA’s E15 Decision

Due to the time sensitivity of farmers’ crop decisions for each year and the desire for farmers to maximize their income to meet the potential increase in demand, the agriculture industry is encouraging the EPA to make their decision soon. Unfortunately, the EPA has delayed their decision on whether or not to approve ethanol blends of 15% in gasoline until the fall of 2010. The primary reason for the delay is the Department of Energy (DOE) has not completed vehicle testing.

Obstacles to the Proposal

In 2009, the EPA advised that they believed E15 would be safe for use in vehicles 2001 and newer. However, recent news articles and testing has raised worries that the EPA may only approve E15 for vehicle models 2007 and newer. This would limit the potential new demand for higher ethanol blend gasoline.

“If the agency were to approve E15 for all cars on the road that would mean a ‘potential increase of 6.5 billion gallons of new ethanol demand…,’ the Renewable Fuels Association said. But if the EPA restricts consumption and confuses motorists on who can use E15, it ‘will likely lead to little if any additional ethanol being sold,’" as reported by Wall Street Journal in the article, EPA Delays Decision Until Fall on More Ethanol in Gasoline.

Restrictions on vehicle use create multiple obstacles for the implementation at all stages from the farmer to the consumer. The ethanol industry is concerned that restrictions would limit demand and economic profit from ethanol.

The restrictions would also cause the cost of implementation to be greater than the potential future revenue. For example, the cost for a gas station to update their infrastructure is a fixed cost whether ten customers or 100 customers use the new 15% blend. If demand is limited, then gas stations may find that the infrastructure cost may exceed the potential revenue.

If the EPA announces an E15 approval, but it is restricted to 2007 and newer vehicle years, the implementation obstacles may cause the approval to have little impact on the demand for ethanol. If the demand for ethanol does not increase, there will be little to no impact on the demand for grains used to make ethanol and the ethanol industry may still be facing the blend wall.

Regulation and Tax

Currently, the volumetric ethanol excise tax credit (VEETC) pays 45 cents per gallon to blenders that use ethanol in their fuel. This tax credit is currently due to expire at the end of 2010. The impact of VEETC expiring may be negative or positive depending on other factors influencing the supply and demand of ethanol.

Support to renew the tax credit includes the need for stable incentives to assure proper infrastructure is built and consumer awareness is achieved. The ethanol industry also argues that not renewing the tax credit may lead to job losses due to a reduction in operating costs. These arguments indicate that not renewing the tax credit will have a negative impact on the ethanol market and create obstacles to achieving the positive impact on demand that would help the United States reach their bio-fuel goal.

Conversely, others believe renewing the tax credit is an unnecessary incentive. Support against renewing the tax credit includes: the belief that a larger market will allow the ethanol market to compete on its own with petroleum, the new standards to meet the Renewable Fuels Standards is already a requirement and adding a tax credit is a double incentive, and the idea that instead of a tax credit to help build the infrastructure, the government should directly supply the new pumps and pipelines

Conclusion

We believe that the EPA will make the increase to E15 as it is the only realistic solution to meet the RFS and reduced the United States dependency on foreign hydro carbons. After the Deepwater Horizon disaster, renewable fuel sources, that are environmentally friendly and add jobs, will continue to become a larger part of the United States fuel supply.

The agriculture industry is very excited for E15 and believes there will be substantial impact on the demand for grains used for ethanol production. The impact will not be felt over night, but will support farmer’s income and the demand for agricultural products.

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